Did the monetary policy environment change in 2011?

Lots of people have pointed me to an article on the zero bound by Eric Swanson:

According to traditional macroeconomic thinking, once monetary policy hits the zero lower bound, there is nothing more the Committee can do to stimulate the economy – monetary policy is essentially ‘stuck at zero’. A corollary of this observation is that fiscal policy becomes more powerful than in normal times because any stimulus from fiscal policy on output or inflation will not be partially offset by monetary policymakers raising interest rates to keep inflation in check. In other words, monetary policy will not act to ‘crowd out’ fiscal policy because interest rates will remain stuck at zero as long as the economy is weak (see, e.g., Mankiw 2013, Chap. 12).

The role of monetary expectations

More recent research, however, has emphasised how monetary policy expectations can alter this reasoning. Reifschneider and Williams (2000) and Eggertsson and Woodford (2003) show that, if the Federal Committee can credibly commit to future values of the federal funds rate, then it has the power to largely work around the zero lower bound constraint. As these authors point out, the economy depends not just on the current level of the federal funds rate (a one-day interest rate), but rather on the entire path of the expected future federal funds rate over the next several years. Put differently, businesses and households typically look at interest rates with maturities out to several years when making investment and financing decisions. Even if the current federal funds rate is stuck at zero, the Committee could continue to push longer-term interest rates lower by promising to keep the federal funds rate low for an extended period of time. In this way, the Committee could continue to stimulate the economy even when the current federal funds rate is constrained by the zero lower bound.

This line of reasoning suggests that monetary policy has probably not been as constrained by the zero lower bound as the traditional way of thinking would imply.  Figure 1 plots the federal funds rate along with the one-, two-, five-, and ten-year Treasury yields. Although the funds rate (solid black line) is essentially zero from December 2008 onward, even the one-year Treasury yield averages close to 0.5% throughout 2009 and 2010, and fluctuates noticeably as the outlook for the economy and monetary policy rose and fell over this period. The two-year Treasury yield is even higher and more volatile. Thus, Figure 1 suggests that monetary policy might not have been very constrained by the zero lower bound until at least mid-2011.

I certainly agree with the primary claim of this article–monetary policy was not very constrained by the zero bound in 2009-10.  But it’s disappointing to see someone call the wacky liquidity trap view “traditional macroeconomic thinking.” Perhaps it could be called traditional old Keynesian thinking, but it was certainly a discredited model by the 1980s, if not earlier.

I’m also a bit uncomfortable with focusing on mid-2011, when 1 and 2-year T-bond yields fell close to zero.  There is nothing special about that date, because there is nothing special about 1 and 2 year T-bonds.  Three-month yields were close to zero throughout 2009 and 2010, and 5-year yields have been well above zero since 2011.  Nothing of importance changed in 2011.  The Fed always has the ability to adopt monetary stimulus if it chooses to do so, as interest rates are not an important part of the monetary policy transmission mechanism.  Of course the Fed ended QE1 and QE2 and QE3 because each time they (wrongly) thought the economy didn’t need any more stimulus.

The paper uses a rather indirect method of trying to ascertain whether monetary policy is constrained.  Swanson looks at whether longer-term bond yields are impacted by economic news. But why not look at whether longer-term bond yields are impacted by monetary news?  And why pick a highly ambiguous indicator like interest rates? Why not look at whether forex prices and stock prices and TIPS spreads are impacted by monetary news?

Nonetheless, I’m pleased that a distinguished economist like Eric Swanson has concluded that monetary policy was much less constrained than many pundits assumed.  At the end of the article, Swanson notes that this implies that crowding out continued to apply after 2008, thus weakening the impact of the ARRA stimulus program.  But crowding out assumes a constant money supply, which is obviously unrealistic.  In fact, “crowding out” depends almost entirely on the degree of monetary offset. I’d like to see the profession stop talking about the crowding out of aggregate demand and move on to the real issue; how do central banks respond to fiscal initiatives?


In a recent post I discussed the astounding 31 point gender gap between men and women on the marijuana legalization question.  Chris Ingraham left this comment:

I’d note that in the exit polls of the most recent ballot measures on marijuana in FL, OR, and AK, the gender gap on support for those measures was much, much smaller – in the neighborhood of 5 points or so. I’d be hesitant to draw too many conclusions from a survey conducted two years ago.

Florida looked at a slightly different question (medical marijuana) and both DC and Alaska are unusual “states.”  So I dug up the Oregon exit polls, which show that Chris is right.  Men favored legalization 58 to 42 while women favored legalization by 52 to 48, a gap of 6 or 12 points, depending on how it’s measured.

So unfortunately my previous post on this topic seems to have been based on false information. There probably is a gap, but it’s not that large.  It’s certainly wrong to generalize by saying “women oppose legalization.”  They split pretty evenly, especially if you assume the national figures would be a couple points lower for legalization, as compared to liberal Oregon.

Update:  Commenter Steve breaks it down by married and unmarried.  The gender gap in Alaska is all in the unmarried, and is slightly larger for the unmarried in Oregon.


The new jobs numbers provide one more bit of evidence in support of the claims I’ve been making in this blog:

1.  Job growth in the first 10 months of 2014 was almost 2.3 million, roughly the amount for the entire 12 months of 2012 or 2013. Thus the total for 2014 will end up being about 400,000 more than the average of the previous two years.  That may reflect the expiration of extended unemployment benefits.  Ditto for the still sluggish nominal hourly wage growth (stuck at 2.0%.) The household survey (less reliable) shows nearly 2.6 million jobs so far this year.

2.  I’ve often referred to the fact that since the beginning of 2013 the unemployment rate has been falling at 0.1% per month, and will continue to do so. It did so again in October, down from 5.9% to 5.8%. That means we are only 4 months from the Fed’s definition of “full employment.”

3.  Some have pointed to the low employment/population ratio as evidence that we are not recovering.  After being stuck in the trading range of 58.2% to 58.8% from October 2009 (when unemployment was 10.0% (exactly 5 years ago)) to February 2014, we finally have a decisive breakout on the upside:

Screen Shot 2014-11-07 at 9.31.11 AM

We also have a breakout for average weekly hours, which were stuck in the 34.3 to 34.5 range for years:

Screen Shot 2014-11-07 at 9.30.11 AM

New claims for unemployment as a share of the workforce keep hitting all-time lows.  Never in all of history did workers have less need to fear layoffs.

No Fed chairman ever had an easier job that Janet Yellen has right now.  Normally you want to tighten before nominal wage growth accelerates.  But in this case the Fed can wait for nominal hourly wage growth to accelerate from 2.0% to 2.5% before tightening, as the 2.0% figure is too low to hit their inflation target.  So the Fed merely needs to wait until wage growth accelerates.  No need to read the tea leaves.

(BTW, when I say “tighten,” I mean raise the fed funds target–policy is already tight.)

The last two years disproves several theories:

1.  In January 2013 unemployment was still 7.9%, and many conservatives were pessimistic about the prospect for monetary stimulus to lower unemployment. They claimed we had “structural problems.”  Now unemployment is 5.8% and still falling fast.  We had a demand shortfall—in early 2013 wages hadn’t fully adjusted to the huge plunge in NGDP growth in 2008-09, and slow recovery.

2.  Liberals claimed “austerity” in 2013 would slow the recovery.  Exactly the opposite happened.

3.  Liberals also claimed that ending extended unemployment benefits would not reduce unemployment (which was itself odd, because prior to 2008 liberals did believe that ending extended unemployment benefits would create jobs.)  In fact the 2008 liberals were right, job growth accelerated in 2014 without any acceleration in wages.  The acceleration was a “supply of labor-side” story.  So while the overall recovery since late 2012 is a demand-side story, the acceleration in job growth after the first of the year was a modest supply-side addition to the recovery.

Despite all this good news, we could have done much better with a more expansionary Fed over the past 6 years.  There are some “structural problems” in America, but they never had much to do with the near 10% unemployment rate of 2009-10.

PS.  Tim Duy has an excellent post demolishing the conservative argument that the Fed is creating growth with “inflation.”

PPS.  Here’s the steady fall in unemployment since January 2013.  In contrast, from January 2012 to January 2013 unemployment had only fallen from 8.2% to 7.9%, which is why so many people were pessimistic “structuralists” at the time.

Screen Shot 2014-11-07 at 9.51.20 AM

PPPS.  The employment-population ratio for the all important 25-54 age group also rose, and has regained 2 points of the slightly over 5 points lost during the Great Recession. There’s still some slack out there.

HT: Garrett McDonald






John Cochrane on the stability of interest rate pegging

Here’s John Cochrane replying to a post by Nick Rowe:

The last 5 years have brought us a delicious opportunity for measurement. Once we hit the zero bound, interest rates can’t move any more. So the whole problem of empirically verifying long run dynamics is a lot easier.

What happened when the Fed kept interest rates at zero for 5 years? Pretty much nothing! OK, you see inflation going up and down, but look at the left hand scale — one percentage point. Given the colossal scale of other events in the economy, that’s nothing. Japan has been at it even longer, with similar results.

We seem to have in front of us a pretty clear measurement that long run dynamics are stable.

“Nothing” is astounding. This dog that did not bark has demolished a lot of macroeconomic beliefs:

  • MV = PY. Sorry, we loved you. But when reserves go from $50 billion to $3 trillion and nothing at all happens to inflation — or at most we’re arguing about percentage points — it has to go out the window.

  • Keynesian deflationary spirals. Just as much as monetarists worried about hyperinflation, Keyensians’ forecast of a deflationary spiral just didn’t happen.

I can certainly understand why Cochrane would make this argument.  It seems to make a lot of sense.  But that’s only because the standard model is infected by Keynesianism, which leaves it vulnerable to attack. Here’s one reply:

Yes, the Taylor Principle stabilizes prices during normal times, when interest rates are positive. And yes a rigid and positive interest rate peg is supposed to lead to highly unstable dynamics.  But that’s because if you target interest rates at a positive level and if there is no interest on reserves, then you lose control over the monetary base, which flies off to zero or infinity.  In contrast, at the zero bound you regain control over the base.  Thus once the Fed and BOJ lost the ability to adjust interest rates, they started using QE to prevent deflation.  (Of course with IOR you hit the “liquidity trap” that much sooner, but regain control of the base that much sooner.)

That’s the sort of reply I’d expect from Nick Rowe.  But then I’d also expect Nick to go further, and point out that this just shows how dangerous it is to describe the stance of monetary policy by using interest rates.  Here’s what actually makes the Taylor Principle work:

1.  When inflation is above target you need to reduce the growth rate of the money supply (relative to the growth rate of money demand) enough to bring inflation back down to the target.  It just so happens that the sort of policy that would reduce the money supply growth by an adequate amount is also one that will result in nominal interest rates rising in the short run (due to the liquidity effect) by roughly 150% of the rise in inflation.  But that rise in interest rates is not why inflation falls back to the target path (it’s an epiphenomenon), it falls back because you’ve reduced the growth rate of the money supply relative to demand.  Inflation falls back for monetarist reasons, not Keynesian reasons.

2.  Now suppose you are at the zero bound.  The Keynesian model requires something radically different, whereas the monetarist model just keeps plugging along with the same old method—adjusting the money supply relative to changes in money demand.  No ad hoc additions are needed for the monetarist model, unlike the Keynesian model.

But what about Cochrane’s criticism of the M*V=P*Y model?  What about his observation that reserves have soared while prices have hardly budged?  Unfortunately, there is no such model.  No one has ever proposed an M*V=P*Y model.  No one has ever claimed that inflation is proportional to reserves.  The most distinguished monetarist of all time was Milton Friedman, who famously argued that reserves are not a good indicator, and that money was tight during the 1930-33 deflation despite the huge rise in bank reserves due to Herbert Hoover’s QE.  There’s nothing new under the sun.  Nothing to be explained here; just move right along.

Sophisticated quantity theorists have always understood that the demand for bank reserves can be very large at zero nominal rates, especially when interest is paid on reserves (but even if it is not.) At the zero bound expectations (which are always about 98% of monetary policy) become 99.5% of monetary policy.  So I guess I was exaggerating a bit; the zero bound really is slightly different, but only quantitatively, not qualitatively.

An interest rate peg can lead to hyperinflation or hyper-deflation precisely because it can lead to upward or downward spirals in the monetary base.  That spiral does not generally occur at the zero bound, and hence there is no “stability” mystery to explain.  Unless you are a Keynesian.

I don’t want to sound too negative here–for some reason I had never really thought about that flaw in the standard Keynesian model until I had to think about how to respond to Cochrane’s post. That’s what makes the blogosphere so great.


The mother of all gender gaps

Commenter Floccina sent me the following interesting finding, from Michele Martinez Campbell:

A fascinating new national poll from Quinnipiac University shows that men and women disagree markedly on the question of marijuana legalization.  While men surveyed strongly favor legalization by a margin of 59 to 36 percent, women oppose it by a clear majority of 52-44 percent.  This 15-point gender gap in support for marijuana legalization –let’s call it the “pot gender gap” — is not quite as large as the 20-point gender gap in support for President Obama in the 2012 presidential election, but it is striking.  What’s most interesting, though, is how it confounds the expectations set by the voting gender gap.  In voting, women trend more liberal and Democratic, while men trend more conservative and Republican.  Yet with the pot gender gap, we see women taking the more conservative, law-and-order approach.

I was a bit puzzled by this claim, as those numbers seem to indicate a 31 point gender gap, the way I usually calculate the gap.  There is an alternative method that would yield a 15 point gap.  However when you follow the link to the supposedly larger 2012 election gender gap, you get the following, from Jeffrey Jones:

PRINCETON, NJ — President Barack Obama won the two-party vote among female voters in the 2012 election by 12 points, 56% to 44%, over Republican challenger Mitt Romney. Meanwhile, Romney won among men by an eight-point margin, 54% to 46%. That total 20-point gender gap is the largest Gallup has measured in a presidential election since it began compiling the vote by major subgroups in 1952.

That uses the approach I am more familiar with. But by that approach, the drug gap is actually 31%, which makes the drug legalization gender gap far larger than the biggest presidential election gender gap ever recorded.  A 31 point gap is mind-boggling by itself, but it’s even more astounding when you consider it reverses the normal liberal/conservative split between men and women.  This fact would tell us a lot about politics, if we bothered to pay attention.  Instead all you see in the media is endless generalizations about the left and the right, as if the views of African-Americans on social issues, for instance, could be understood simply by noting the fact that they tend to vote Democratic.  People are really complicated.

NarcoLaw’s best guess (an informed guess, but a guess nevertheless) is that female opposition stems from questions about the impact legalization will have on public health, crime and the social fabric.

I think the health/social fabric worries are wrong—but defensible.  But the crime argument isn’t even defensible.  Of course that’s just one person’s “best guess,” it would be interesting to get better data.  Why isn’t this issue being intensively studied?  What are the gender gaps on government invasion of privacy (TSA/NRA/CIA, etc?)  What is the gender gap on immigration?  I have no idea what the gap is on many of the most important issues facing our country, and no reason to think it correlates in any particular way with how each gender votes. (Democratic pols are supposedly more likely to support legalization.–but is even that true?  Is there any data?)

BTW,  I have many commenters in both the liberal and conservative camps.  But they almost all seem to favor drug legalization.  And I’d guess over 90% are male.  There are entire realms of our political reality that are almost invisible in the blogosphere.

PS.  There are also some big gender gaps in academics, which are just as perplexing as in drug legalization.  For instance, women get higher grades in college, despite getting lower average scores on SATs.  This might reflect some sort of difference in cognitive styles.  Let me throw out a hypothesis (and feel free to scold me for sexism if appropriate.)  Is it possible that men approach the issue from more of a “legalistic” perspective.  I.e. “legalizing drugs doesn’t mean one endorses their use.”  And women might approach the issue from a more “contextual” framework; “while legalization doesn’t necessarily endorse their use, it implicitly connotes the fact that society regards drug use as ‘OK’.”   It seems to me that women are at least slightly more likely to say things like “so what you are really saying is . . .”   Another thought is that men might be more individualistic; “no one can tell me what I can or cannot do,” whereas women might be more used to thinking in a social context; “how does this impact the family?”  These might all be stereotypes on my part, but the gender gap is certainly very real; 31 points is way outside the margin of error for a public opinion poll.  Marijuana is illegal in America mostly because women want it illegal.  Just to be clear, I am not trying to pick on women here.  My views on other issues like use of military force and reproductive rights are more “feminine” than masculine.

PPS.  A gap that big cannot be accounted for by the fact that somewhat more men than women use illegal drugs.  Or by the fact that women care more about children.  Do dads want their sons to get addicted?  And do moms really want their sons to go to prison?

PPPS.  Off topic, I love this Sunstein post on Hayek.